Bond Traders Lean Toward Higher Yields Amid Georgia Runoff

(Bloomberg) -- The betting markets have been factoring in a greater chance of a Blue Sweep in Tuesday’s U.S. Senate runoff election results in Georgia, and rates traders appear to be suitably positioned for that outcome.

The outcome of the vote, results of which will likely be known Wednesday morning, is seen as having huge implications for Treasury supply this year, as well as the direction of yields. A unified Democratic government is expected to provide a green light for additional fiscal stimulus, spurring more bond issuance and higher yields on longer-maturity Treasuries.

Traders seem to be bracing for that prospect, driving yields higher and the yield curve steeper on Tuesday, with a key measure reaching the steepest in four years. It gained momentum after stronger-than-expected manufacturing data and a large futures block sale.

Separately, the latest JPMorgan Chase & Co. Treasury client survey found the biggest share with short positions since October 2018, an indication of expectations that yields are set to rise. And in Treasury options, the cost of buying puts to protect against an upside move in long-end Treasury yields over the next month, versus purchasing calls to hedge against a downside move, has become skewed to the most since November.

In eurodollar options, a similar theme has emerged with positions reflecting the expectation of a steeper Treasuries curve, driven by long-end yields rising at a faster pace than intermediates. The bear-steepener trade stands to spring to life should Democrats gain control of the Senate.

In a sign of wariness about the long end, total put volume on the $19 billion iShares 20+ Year Treasury Bond exchange-traded fund has spiked to the highest since November, data compiled by Bloomberg show, as investors protected against higher yields.

Yet the rate on Treasury 10-year notes has still failed to crack 1%, even as real yields have dropped to a record low in a sign of rising inflation expectations. Part of the stall-out in nominal yields may be a result of soaring virus cases and concern about the impact on the global economic recovery.

Some traders have positioned for this low-volatility regime to continue -- a scenario that may unfold if Republicans keep control of the Senate. That positioning is reflected in a large short position at the 137 strike in 10-year note options, which built further on Tuesday afternoon. It stands to make money as long as any increase in 10-year yields is confined to around the 1% level. The yield is now about 0.95%.

Should the Democrats achieve a Blue wave outcome, there appears scope for 10-year yields to extend through 1% in the near-term, given the backdrop of rising inflation expectations, heavy corporate issuance and the start of chatter around the potential tapering of the Federal Reserve’s bond buying.

Inflation expectations are also on the rise, particularly with oil surging. Traders now see U.S. inflation averaging just over 2% per year over the coming decade, the highest level since late 2018.

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